Chapter 1: Accounting information and decision making

Part A: Accounting as a measurement and communication process

I. Defining accounting
A. Accounting- a system of maintaining records of a companys operations and
communicating that information to decision makers
1. Earliest use dates back to Mesopotamia to keep track of agriculture
B. Functions of accounting:
1. To measure the activities of the company
2. To communicate those measurements to people
C. Two category of accounting
1. Managerial accounting deals with the methods accountants use to provide
information to an organizations internal users (managers)
2. Financial accounting measure business activities of a company and to
communicate those measurements to external parties for decision-making
purposes (investors and creditors)
a. Investors- buying and selling the companys stock
b. Creditors- lending the money to the company
II. Business activities to measure
A. A business engages in 3 fundamental activities
1. Financing activities- external sources of funding (owners and creditors)
2. Investing activities- purchase and sale of long-term resources (land, buildings,
equip, machinery) and any resources not directly related to a companys normal
operations
3. Operating activities- primary operations of the company (utilities, taxes, wages,
rent, maintenance)
B. First role of financial accounting is to measure a companys financing,
investing, and operating activities
C. Measurements of business activities- investors and creditors want to know about
the companys resources and their claims to those resources
1. Assets- resources owned by a company
a. Cash- make purchases
b. Inventories- make product sales to customers
c. Supplies- perform basic business functions
d. Buildings- location to operate a company
2. Liabilities- amounts owned to creditors (must be paid by a specified dates)
3. Stockholders equity- owners claims to resources (asset- liability= stockholders
equity)
4. The accounting equation shows that a companys resources (assets) = creditors
plus owners claims to those resources (liabilities and stockholders equity). Asset
= liabilities + stockholders equity. This equation illustrates a
fundamental model of business valuation.
5. Revenues- Amounts earned from selling products or services to customers
6. Expenses- Costs of providing products and services
7. Net income- difference between revenues and expenses (net loss= when expenses
> revenue)
8. Dividends- Cash payments to stockholders
D. Forms of business organization
1. Sole proprietorship- a business owned by one person
2. Partnership- a business owned by two or more persons
3. Corporation- an entity that is legally separate from its owners
a. Advantages: Limited liability- stockholders are not held personally responsible
for the financial obligations of the corp
b. Disadvantage: Double taxation- company pays income taxes from income, then
stockholders pay personal income tax on dividends
III. Communicating through financial statements- periodic reports published by the company
for the purpose of providing information to external users
A. Four types of financial statements:
1. Income statement- a financial statement that reports the companys revenues and
expenses over an interval of time

2. Statement of stockholders equity- a financial statement that summarizes the

changes in stockholders equity over an interval of time
a. reporting period same as the income statement
b. common stock + retained earnings = stockholders equity
1. common stock- amounts invested by stockholders= external source of
stockholders equity
2. retained earnings- the cumulative amount of net income that has not been
distributed as dividend to stockholders = internal source of stockholders
equity
a. retained earnings= net income dividends
c. the company creates value externally through stocks and internally by profit
3. Balance sheet- a financial statement that presents the financial position of the
company on a particular date
a. Assets= liabilities + stockholders equity
4. Statement of cash flow- A financial statement that measures activities involving
cash receipts and cash payments over an internal of time, classified into 2
categories
a. Operating cash flow- revenue and expenses
b. Investing cash flow- purchase and sale of investments and long-term assets
(more than 1 yr)
c. Financing cash flow- borrowing and repaying debt, issuing stock, paying
dividends
B. The links among financial statements
1. Any transaction that affects the income statement ultimately affects the
balance sheet through the balance of retained earning

C. Other information reported to outsiders

1. Managements discussion and analysis (MD&A)- managements views on
significant events, trends, and uncertainties pertaining to the companys
operations and resources
2. Note disclosure- additional information either to explain the info presented in the
financial statements or to info not included in the financial statement
Part B: Financial accounting information
IV. Is financial accounting important?
A. Free-market- firms are allowed to compete and customers are free to choose from a
variety of products and services
1. Competition determines everything (prices, salaries, supplies, etc)
B. Financial accounting serves an important role by providing info useful in investment
and lending decision
C. Financial accounting net income= best info to determine a company stock
price performance (its the bottom line in the income statement)
D. A companys debt level is an important indicator of managements ability to respond
to b business situations and the possibility of bankruptcy
V. Rules of financial accounting: Generally accepted accounting principles (GAAP)- rules of
financial accounting, which allows for accurate comparison of financial info among
companies
A. Current standards setting
1. Established by Financial Accounting Standards Board (FASB)- an independent,
private body that had primary responsibility for the establishment of GAAP in the
US
a. FABS members: accounting professions, large corps, financial analysts,
accounting educators, gov agencies

B.

C.

D.

VI. An
A.
B.

C.

2. Because accounting and reporting standards are different worldwide, International

Accounting Standards Board (IASB)- an international accounting standard-setting
body is responsible for the convergence of accounting standards worldwide
Historical perspective on standard setting
1. After the stock market crashed, people wanted to establish an uniform accounting
standards
a. People blamed financial accounting for the stock market crash
b. Companies reported inaccurate info to enhance their reported performance,
hence raising their stock values
2. Laws established to bring back order
a. 1933 Securities Act- set forth accounting and disclosure requirements for initial
offerings of securities (stocks and bonds)
b. 1934 Securities Exchange Act- created the Securities and Exchange
Commission (SEC)- require companies to prepare financial statements for
distribution to investors and creditors
c. SEC only gave FASB the responsibility of set standards, not the authority
The role of the auditor
1. Some managements may cook the book-purposely providing misleading
financial accounting info
2. To prevent this, SEC also require examinations by auditors- trained individuals
hired by a company as an independent party to express a professional opinion of
the accuracy of that companys financial statements
3. Adds credibility to a companys financial statements
Objective of financial accounting is to provide info that is:
1. Useful to investors and creditors in making decisions
2. Helps to protect cash flow
3. Tells about economic resources, claims to resources, and changes in resources and
claims
ethical foundation
Part of accounting is the need for a strong foundation of ethical behaviors. Ethics- a
code or moral system that provides criteria for evaluating right and wrong behavior
Mistrust in the financial reporting process led to the Public Company Reform and
Investor Protection Act of 2002, also known as the Sarbanes-Oxley Act (SOX)
1. Regulation of auditors and types of services they furnish to clients
2. Increases accountability of corporate executives
3. Addresses conflicts of interest for securities analysts
4. Provides for stiff criminal penalties for violators
As accountant, we must develop our abilities in recognize the right and wrong in an
ethical situation

Part C: Careers in accounting

VII. Demand for accounting
VIII.Career options in accounting
A. Public accounting
B. Private accounting
C.